Pensions have long been one of the primary employment benefits designed to retain employees and help them attain financial security through their retirement years. Under a defined benefit plan, the benefit that an employee receives is normally based on the length of the employee's employment and the wages that he received. The money to support the pensions in a defined benefit plan is generally administered through a trust established by the employer for the benefit of the employees.
Pensions under a defined benefit plan are governed primarily by federal statutory law. Congress passed the Employee Retirement Income Security Act (ERISA) under its Constitutional mandate to regulate interstate commerce. The act was passed in response to the mismanagement of funds in direct benefit plans. All employers who engage in interstate commerce and provide defined benefit plans to their employees must abide by ERISA guidelines.
ERISA is highly complicated and provides detailed regulations for many aspects of defined benefit plans. ERISA requires that employers provide both the Labor Department and their employees with detailed descriptions of the benefits they are to receive. It also outlines which employees must receive a pension if one is offered, and it requires that a percentage of the retirement benefits become vested in the employees after they have worked for a given number of years and/or have reached a given age. ERISA also requires that pension plans provide benefits to an employee's survivors upon his death. Companies that offer pension plans must be prepared to provide this information to their employees (Plan Participants) who retire, leave the company, become disabled, or die. The information must also be available to participants that remain employed.
Employers must adequately fund the program and adhere to fiduciary responsibilities established by the act. ERISA has established the Pension Benefit Guaranty Corporation (PBGC) to insure defined benefit plans. Employers must pay premiums so that their plans are covered by the PBGC. The termination of plans is also extensively regulated.
To encourage employers to provide pension plans that follow Congressionally established guidelines such as ERISA, Congress has authorized tax breaks to employers who follow the guidelines. Title 26 (the Internal Revenue Code) establishes numerous qualifications and requirements in order for an employer to receive special tax treatment. For example, pension plans must be vested and must meet minimum coverage requirements. Adherence to tax code requirements further complicates the administration process.
There are nearly 38,000 private defined benefit pension plans that are expected to provide retirement incomes for more than 43 million American workers. Administration of these pension plans is complex, cumbersome, and often expensive. They require oversight by certified actuaries. Pension plan administration and reporting processes vary widely across organizations and cost some organizations as much as $1,500 per employee per year. The high cost of pension plan administration and reporting is attributable in part to the continuously evolving regulatory framework that administrators are required to follow. The federal statutes, rules, and regulations that apply to the plans are enforced by the IRS and other agencies. Defined benefit pension plans must comply with definition requirements as well as reporting requirements established by the IRS, Department of Labor, and the PBGC. Each year, companies with defined benefit pension plans are required to produce a valuation report that is reviewed by an actuary who certifies that the plan is adequately funded. Valuation reports are typically 50-60 pages in length and contain the results of an immense number of calculations. Employer data, relevant IRS code sections, and actuarial assumptions and methods are used to determine pension contribution requirements and financial reporting information. This information may have a significant impact on a company's fiscal planning.
Pension mathematics that are required to determine whether a plan is adequately funded are extremely complex. Ten of thousands of discrete formulas may be needed to complete the necessary calculations for a plan. In addition, there is a tremendous amount of interdependency between the formulas. Attempts to hardcode the mathematics into computer systems often fail due to high error rates in translating the formulas into source code.
Compliance with current laws is critical to the success of defined benefit pension plans. Pension plans that fail to meet the requirements imposed by the IRS, Department of Labor, and PBGC may be disqualified. Liability for non-compliance can be high. The plan administrator may be required to take corrective actions to bring the plan into compliance. In addition, the administrator of the non-compliant plan may be sued by employees or clients for failure to administer a compliant plan and may be required to pay monetary damages.
Pension plan administrators need to be able to monitor for ongoing compliance with the complex regulatory framework that has been established by the IRS, Department of Labor, and PBGC. Pension plan administrators also have a need for tools that address complex plan scenarios and frequent regulatory changes. Solutions that have been developed to today are customized for a particular pension plan. No solution available today incorporates the universe of highly complex pension plan provisions and actuarial logic into a single system.